Advantages of Index Exchange Traded Funds (ETFs)
Tax efficiency
ETFs, like index funds in general, tend to offer greater tax benefits
because they generate fewer capital gains due to low turnover of the
securities that comprise the portfolio. Generally, an ETF only sells
securities to reflect changes in its underlying index. Exchange
trading of ETFs further enhances their tax efficiency. Investors who
want to liquidate shares in an ETF simply sell them to other investors
through exchange trading. Because of this unique structure, ETFs are
not required to sell securities to meet investor cash redemptions,
potentially generating capital gains tax liability for remaining
investors. Keep in mind that the sale of an ETF will generate capital
gains/losses for the investor liquidating shares.
Lower costs
Expenses can have a significant impact on returns for investors. ETFs,
in general, have significantly lower annual expense ratios than other
investment products. ETFs are less likely to experience high
management fees because they are index-based, not "actively"
managed.
History of outperforming Actively Managed Funds
Historical results demonstrate that the majority of all actively
managed equity mutual funds do not outperform the major market
benchmark index. Buying the index will outperform the majority of
active mutual fund managers.
Transparency
ETFs are designed to generally replicate the holdings and correspond
to the performance and yield of their underlying index.
All day tracking and trading
ETFs are priced and traded throughout the day, and are not restricted
to once-a-day trading at the end of the day. And because the pricing
of ETFs is continuous during trading hours, investors will always be
able to obtain up-to-the-minute share prices from their broker or
financial adviser.
Diversification
Because each ETF is comprised of a basket of securities, it inherently
provides diversification across an entire index. ETFs cover
virtually every segment of the equity markets and several segments of
the U.S. bond market, providing an easy and convenient way to adjust
the investment mix of a core portfolio
Core investment
Investors
can use ETFs as a core investment for their portfolio. The purchase of
shares in a single ETF can provide broad market exposure of a
portfolio of stocks or bonds for long-term holding that is easy to
establish, easy to track, inexpensive, and tax efficient.
Hedging
Exchange traded funds can be purchased on margin and
sold short (even on a downtick), which has opened up risk management
strategies for individual investors that were once available only to
large institutions. For example, ETFs can be sold short to hedge a
core stock portfolio or interest rate fluctuations. This allows
investors to keep their portfolio intact while protecting it from
market losses. In a declining stock market or rising interest rate
environment, profits from a short position can offset some of the
losses in a portfolio. (Investors are required to make arrangements to
borrow securities before selling short.) Listed options, available on
some ETF products, also offer opportunities for additional hedging or
to increase income. Investors should contact their broker regarding
initial and maintenance margin requirements. To view a list of ETF
options that are listed at the Amex, click here.
Cash
management
ETFs have often been used to "equitize" cash, providing
a way for investors to put cash to work in the market or maintain
allocation targets while determining where to invest for the longer
term.
Rebalancing
Investors can adjust ETF positions at any time
throughout the trading day, without redemption fees or short-term
restrictions. Again, usual brokerage commissions will apply.
Tax loss strategy
An investor can sell a security that is
underperforming and claim a tax loss but retain exposure to its sector
by investing in an ETF. Consult a tax advisor about a tax loss
strategy.
Buying and selling flexibility
-
bought and sold at intraday market prices
-
purchased on margin
-
sold short, even on a downtick (unlike common stocks)
-
traded using stop orders and limit orders, which allow investors to
specify the price points at which they are willing to trade
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